Thursday, January 24, 2013

The 12 Rules to Follow for Buying Dividend Stocks

Many of you have probably filled out one of the "retirement planner" forms available online. Plenty of tax and accounting programs also have "Lifetime Planner" sections for folks to determine if they can afford to retire.

These sorts of programs plug certain assumptions into a formula, such as projected inflation rate, retirement income, anticipated spending levels, and portfolio growth rate. After you add your personal information, it projects how much money you'll be able to produce annually during retirement, and how long it will last.

The first time I ran these numbers, the program said I was good until 116 years of age. At the time, I believed that if we followed the plan as outlined, my wife and I would never have any real money worries. We'd be set for the rest of our lives and could proudly leave some to our children to help with their retirement. How naïve of me!

Things have sure changed a lot since then.

At the time, I'd estimated inflation at 2% and a minimum yield on our portfolio of 6%. In those days, that was conservative. Inflation was lower than 2%, and you could always earn 6% on a top-rated bond or CD.

Many retirees and baby boomers are now rethinking the entire retirement process. CDs and top-quality bonds no longer pay enough interest to keep up with inflation.

With these options out of the picture, it's no wonder the stocks of big, solid, dividend paying companies are soaring. Investors hoping to earn a higher return are pouring money into them with the hope of staying ahead of inflation.

I'm a firm believer that the days of buying a company stock, putting it in a drawer, and never worrying about it again are over. At the same time, folks contemplating their retirement finances will likely have long term relationships with certain dividend paying stocks.

While working on our special report our lead analyst, Vedran Vuk, really showed me how to sort through hundreds of dividend paying stocks. I wanted to share some of the tips I learned during the process.

Tip No. 1: Long History of the Company Paying the Dividend

Tip No. 2: Payout Ratio of No More Than 80% of the Company's Earnings Per Share

When our team compiled the list of dividend-paying stocks, they listed them by yield going from the highest to the lowest. Naturally, I went straight to the top of the list.

But our analysts quickly pointed out that if a company earns $0.50/share and is paying a dividend of $0.75/share, it could be in trouble. It's important to compare the earnings per share and the dividends per share of any investment candidate.

If you're considering investing in a company with an unusually high payout ratio, always investigate where the money to pay the dividends is coming from.
Tip No. 3: Worldwide Market Presence
The Miller’s Money Forever team is very concerned about inflation of the US dollar. Companies that do business all over the world provide somewhat of a hedge against inflation. McDonald's, Coca Cola, Procter & Gamble, and General Mills are a few household names that come to mind.

Tip No. 4: Stable Product Line

Whether its beer, food, oil, or computer chips, the company you're investing in should have a core business with a worldwide need for its product.

Tip No. 5: Lots of Cash

This is why I bought and continue to hold Microsoft. Companies like Microsoft have plenty of cash and can pay their bills with plenty of money left over to reward their stockholders.

Tip No. 6: The Company Sticks to Its Core Business

During the Internet boom, many companies were swapping stock and buying up businesses all over the place. To this day, I do not understand why AOL Time Warner made sense as a business.

You can always follow a company's progress and invest if you think it's going to dominate a new business venture.

Tip No. 7: Stock Price Stability

Benjamin Graham, author of The Intelligent Investor, recommended a portfolio of stocks and high-quality bonds. Under his model, you switch part of your portfolio back and forth between the two, depending on market conditions.

While that may have worked for him, the yield on fixed income investments today no longer allows for that. You need to continually remind yourself that no matter how big or stable a company, its stock price can still fall.

But safety is our main concern. You should study the history of any stock you're considering to see how volatile it is during market turmoil.

Tip No. 8: Diversification is Good

Some of the better yields are in sectors that experience more volatility. A prudent investor will diversify his dividend-paying stocks among different sectors to reduce the overall impact of market swings.

Tip No. 9: The Company Has a History of Buying Back Stock

It's a big plus if the company has enough earnings to pay good dividends and buy back stock at the same time. Having stock appreciation in addition to generous dividends is your overall goal.

Tip No. 10: The Company Has a History of Increasing Dividends

It's prudent to check a company's dividend history to see if there's a pattern. Many old line moneymakers have done very well for their shareholders by increasing their dividends every year.

Tip No. 11: Check the Current Dividend Yield Percentage

There are many good dividend paying stocks out there, but you should factor in the price of any company you're considering.

Companies like McDonald's, Walgreen Co., and Shell have traditionally met our own requirement of 3% or higher. There are dozens of other good companies with good dividend yields.

Tip No. 12: Set a Trailing Stop Loss

It's time to remind yourself again that dividend paying stocks do not offer the safety of a top rated bond or FDIC insured CD. As a retiree or someone considering retirement, preserving your investment principal is paramount.

You don't want to ride a stock down just to see your dividend income eaten up in loss of principal. A stop loss helps to keep that from happening.

A traditional stop loss uses a fixed price. If you buy a stock for $100 and put in a 20% stop loss on it, you have an immediate sell order on it if the stock drops to $80.

The sell order is executed automatically by a computer. If you trade online, it's easy to enter the stop-loss order when you purchase the stock.

A trailing stop loss is a little more sophisticated; it adjusts the start point every time the stock hits a new high. This gives investors the potential to lock in some profits and still protect themselves.

Assume that you bought the same stock for $100/share and put in a trailing 20% stop loss order. You may end up holding the stock for years; collecting dividends along the way and watching the stock appreciate.

Imagine that the stock hits an all-time high of $200/share. The trailing stop loss will trigger an automatic sell order if the stock drops 20% to $160/share. In this illustration, the trailing stop loss protected your investment, but you still earned a $60/share profit, plus the dividends you've collected over the years.

When you enter your stop loss order, make sure to mark it "good until canceled." My online brokerage enters every order for the day and then cancels it after the market closes unless they receive instructions to enter it for a different period of time.

Some online brokerages work differently. Even with a "good until canceled" order, some will cancel the order automatically after 60 days, and you have to reenter it. That's not necessarily a bad thing, because it's a good time to review your investment anyway.

Take Comfort In Having a Plan

There's comfort in having a portion of your portfolio invested in solid companies that pay nice dividends. Retirees have to be much more active in managing their money than in the past.

Being a part owner of some of the finest businesses in the world and sharing in the profits is a lot of fun.

Like most areas of investing, finding the right companies and buying them at the right price are the major factors. It just takes a little time and common sense to sort through the hundreds of good possibilities and select the right ones for your individual situation.